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Real Estate’s 5% Rule (and Why Investors Should Use It!)

Hurricane Property Owner Making Calculations at a DeskIt’s a common misconception that you need to own your own home before buying investment properties. And the information definitely shows that in the past, living the “American Dream” meant homeownership and a nice car or two in the driveway. Yet, shifting ideas, modern lifestyle preferences, and even a renewed unwillingness to commute to work have brought huge shifts in rental real estate investing.

It depends on where you reside and your standard of living; it may make more sense to rent your home while you build an investment portfolio. To understand whether you should rent or buy your primary residence, you may (and have to) apply what’s known as the 5% rule.

The 5% Rule

The 5% rule is an easy technique to figure out whether it costs more to buy or rent a home. On the renting side, figuring your cost is straightforward: it’s the amount you pay in rent every month. On the homeownership side, though, it might be a little more complex. The costs of owning a residential property incorporate more than simply your mortgage payment. This is where the 5% figure occurs. It is a technique to compare the cost of renting to owning a home.

How It Works

The three main components of the 5% rule include property tax, maintenance costs, and the cost of capital. These are costs that homeowners undertake, and renters do not. Let’s break down each one:

  • Property tax. Applying this simple method, the cost of property tax would be roughly equal to 1% of the home’s value.
  • Maintenance costs. Regular maintenance and repairs are also something homeowners spend more often than renters do. As an illustration, property tax, this is likewise supposed to be around 1% of the house’s value.
  • Cost of capital. The cost of capital makes up the remaining 3% of the 5% rule. In simplified terms, the cost of capital is what you could be collecting on the money tied up in your home (usually in the form of a down payment) if it was invested in some other kind, such as an investment property or the stock market. It’s a cost because of the interest you pay on your mortgage, often around 3%.

Applying the 5% rule would look such as this:

  • Multiply the value of the property you own/desire to purchase by 5%.
  • Divide by 12 (to get a monthly amount).
  • If the resulting amount is more expensive than you would pay to rent an equivalent property, renting your home and investing your money in rental properties might appear acceptable.

Why You Should Use It

While the 5% rule is an oversimplified way to compare the costs of renting with homeownership, it can be a beneficial tool for rental real estate investors. You can utilize it not only to make personal judgments about your personal residence; if you own rental properties in areas where the cost of living is high, you could also teach it to your tenants to assist them in recognizing the benefits of staying in your rental home longer. In markets where property values are very high, this technique might definitely be an excellent resource as you make all future real estate investments.

 

Are you eager to make your next move as a rental real estate investor? Our Hurricane property managers can aid! Contact us online for more information on finding and evaluating investment properties.

We are pledged to the letter and spirit of U.S. policy for the achievement of equal housing opportunity throughout the Nation. See Equal Housing Opportunity Statement for more information.